GST and its wrinkles

If GST can be tweaked upward just by the executive, it will become more and more regressive, worsening inequality.

The roll-out of the goods and services tax (GST) is the most important indirect tax reform since independence. It is a big deal and goes to the heart of centre-state relations. It is a potential game-changer in the realm of what Prime Minister Narendra Modi has called “cooperative federalism”. It’s a grand bargain between the 29 states of India and the centre. The states give up their right to impose sales tax (and other sundry taxes), and the centre gives up its right to impose excise and services tax. In exchange, they each get a share of the unified GST.

Collection will be buoyant since the new system has interlocking incentives that will increase tax compliance. Inter-state commerce will be free of friction of entry taxes and the deadweight burden of central sales tax. Smaller producers can now reach and sell to all India customers, not constrained by the intra-state sales tax system. Companies don’t need to dodge taxes by showing movements across state lines as intra-company depot transfers. There will be efficiency gains due to the removal of the cascading impact of multiple taxes.

GST is certainly a landmark reform, but it is not the magic bullet that cures all pending economic reforms. For example, tax reform is only one component of the larger agenda for improving India’s ease of doing business ranking. More importantly, the roll-out of a nationwide GST also raises some concerns, which have to be acknowledged, and hopefully resolved in due course of time. Here are five important issues revolving around GST.

1. Federalism: Does GST enhance federalism? If we look at large country peers, the US does not have a centralized GST. In fact, many states in the US have the power to impose income tax in addition to state-level sales tax. In the European Union (EU), each member-state (country) has retained fiscal autonomy. The Maastricht Treaty only forced members to remain within the limit of fiscal deficit of 3% of gross domestic product (GDP). Even this ceiling was breached early on by EU’s two biggest members, France and Germany. After the sovereign debt crisis starting with Greece, and after Brexit, all bets are off. The fiscal rebellion may spread. China does have a national GST, but spending and resource raising autonomy given to provinces (states) is immense. Indeed, the governors’ performance is purely linked to capex and GDP growth, and they enjoy de facto fiscal autonomy. In comparison to the US, EU or China, the GST in India will greatly curtail the fiscal autonomy of states. It is unlikely that we will have income tax powers bestowed on state governments.

2. Progressivity: The GST is an indirect tax. The poor bear a disproportionate burden of indirect taxes. India has a very low direct tax-to-GDP ratio. The ratio of direct to indirect taxes in India is 35:65. This is exactly the obverse of most of the developed world. Income tax rates have steadily reduced, whereas service tax rates have gone up from 5% in the mid-1990s to 15% now. Swachh Bharat and Krishi Kalyan cesses are recent examples of new indirect taxes. Less than 5% Indians file income tax returns, but almost all Indians pay indirect tax in one form or another. A starting GST rate of 18% (as per current discussion) will hurt the poor more than the rich. Early discussion was around a GST rate of 12% or 13%, which has now drifted to 18%. At 20% or higher, we might as well not have a GST.

3. Legislative cap on GST: Excise duties on petrol and diesel were raised almost a dozen times in the past one-and-a-half years. These are indirect taxes. Did we pause to wonder, how is it that the excise duty hikes did not require parliamentary approval? That’s because the frequent tax hikes were executive action, empowered by emergency “war powers act”. If GST can be tweaked upward just by the executive, it will become more and more regressive, worsening income inequality. Hence a legislative cap (via the bill, not necessarily in the Constitution) is needed to prevent future misuse. Bear in mind that tax buoyancy (and elasticity) of a tweak from 18% to 19% is much higher, and hence easier than widening the direct tax net. We need to curb this temptation to increase taxes through a legislative restraint, i.e. a cap on the GST rate.

4. Council governance: GST disputes will be thrashed out in the GST council. Small and large states will have equal voting powers. Is this fair? Large producing states like Maharashtra already fear losses in excess of Rs.14,000 crore in the first year itself. It is asking for larger reimbursement. Other voting states may “gang up” against Maharashtra and veto such a proposal. What if a larger state wants to impose a higher “sin tax” or give a bigger subsidy at the lower end of the GST slab, since they can afford it? Will the current governance framework provide such a leeway?

5. Tax disputes: The power of the sales tax commissioner at the state level enables speedy resolution of disputes. But the excise framework uses the process of appeals and tribunals, involving interminable delays. This distinction is called the “revision” versus “review” approach. Will the GST lean the excise way, or sales tax way? Will we soon have a mountain of disputes and long judicial delays?

Hopefully each of these wrinkles can be straightened out, once the GST gets going. But the economic benefits of the GST should not blind us to its imperfections.

Ajit Ranade is chief economist at Aditya Birla Group.

Source: http://www.livemint.com/Opinion/mPmVJNLjUra2ZVXasKEu2N/GST-and-its-wrinkles.html

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